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Wednesday, 8 October 2008
Hedge Fund Finds Itself on Defense
Kenneth C. Griffin was one of those Wall Street whiz kids. As a teenager, he traded out of his dorm room at Harvard. In his 20s, he opened his own hedge fund. In his 30s, he boasted that his company might one day rival Goldman Sachs. PDF
Kenneth C. Griffin was one of those Wall Street whiz kids. As a teenager, he traded out of his dorm room at Harvard. In his 20s, he opened his own hedge fund. In his 30s, he boasted that his company might one day rival Goldman Sachs.
But it can be tough for a boy wonder to grow up — particularly in the midst of the gravest financial crisis since the Depression. A week before his 40th birthday, Mr. Griffin finds himself in an unaccustomed position: on the defensive.
The Citadel Group of Chicago, the giant hedge fund that Mr. Griffin has run so successfully for nearly 20 years, is leaking money. As of Sept. 30, its two main investment funds were down 20 percent this year, according to Citadel investors. Most of the losses came in the last few weeks, when the markets swooned. Two other smaller Citadel funds are still well in the black.
While many hedge fund high-fliers are falling back to earth this year, few have soared quite as high as Mr. Griffin. With an estimated net worth of $3 billion in 2007, he ranked as the 117th richest American, according to Forbes. (Mr. Griffin paid $60 million for Cezanne’s “Curtain, Jug and Fruit Bowl” in 1999. Four years later, he was married in the garden at Versailles.)
But with the entire hedge fund industry on edge, even Mr. Griffin is considering what once would have been unthinkable: reducing some of the lavish fees that investors pay Citadel to tend their fortunes.
Citadel is developing several new, low-price funds that will eschew the industry’s “2 and 20” structure, whereby funds collect annual management fees of 2 percent and, on top of that, take a 20 percent cut of any profits. Some of the funds will bet only on investments and will not use short sales to hedge, effectively taking the “hedge” out of hedge fund. The funds will provide investors with a menu of à la carte investing options, another departure for Mr. Griffin, as he expands beyond hedge funds into broader asset management.
Gerald A. Beeson, the chief operating officer of Citadel, said no one had seen anything like the turmoil now gripping the financial markets. “Any one of the market events we saw in September could on its own result in a meaningful dislocation,” Mr. Beeson said. “Together they were simply unprecedented.”
Until now, Mr. Griffin has rarely stumbled. Between 1998 and 2007, he handed his investors an average annual return of 20 percent, more than three times that of the Standard & Poor’s 500-stock index. That performance made Mr. Griffin a rich man and fanned his already formidable ambition. Not long ago, he was considering taking Citadel public, a step that might now be difficult, if not impossible, given the state of the markets. Through a spokeswoman, Mr. Griffin, who turns 40 on Oct. 15, declined to comment for this article.
What went wrong? Citadel’s losses this year were largely caused by equity trades and two arbitrage strategies, the first of which involves betting on the outcome of mergers, and the second on convertible bonds.
Now, the clock is ticking for Mr. Griffin. If his funds close down for the year, Citadel will not earn its 20 percent profit fee and will have to finance its growth through past savings. Dismal year-end returns could also put another dent in Mr. Griffin’s aspirations for taking his company public.
Hedge funds are down, on average, 10 percent so far this year, the worst run yet for the private, largely unregulated industry that manages money for some of the largest pension and endowment funds in the world. The losses are threatening the survival of thousands of hedge funds, and pitting traders against each other. As the markets rumbled last month, troubled hedge funds sold investments at rock-bottom prices, and other, stronger funds tried to bet against any stocks or bonds that their weaker peers held.
“The real issue for hedge funds is that the whole environment has changed, and like everyone else, they’re trying to figure out whether they still have some kind of investment edge in this new environment,” said William Goetzmann, a professor of finance at the Yale School of Management. “I think some of them will find that they don’t.”
Already, investors are starting to ask for their money back at large hedge funds like DKR Capital and RAB Capital. Managers like Dinakar Singh, a former Goldman star who runs the hedge fund TPG-Axon, are writing apologetic letters to their investors, asking them to stay put. And analysts are warning that some 10 percent of the 10,000 hedge funds in business may be gone by early next year.
It is a setback for an industry that has created staggering wealth for individuals like Mr. Griffin and raised eyebrows in Washington. The House Committee on Oversight and Government Reform said last week that it would hold a hearing on hedge fund regulation next week, and Mr. Griffin is among the five billionaire hedge fund managers invited to testify.
Citadel is already mapping changes to put it ahead when the chaos ends. The company has been hiring Wall Street workers for its new, low-price funds, a move that angered JPMorgan Chase so much that the bank stopped trading with Citadel for a day. And Citadel has been working on creating a new exchange and clearinghouse for credit-default swaps with the Chicago Mercantile Exchange, an alternative to a plan being promoted by Wall Street firms like Goldman Sachs.
A fiercely competitive trader, Mr. Griffin has weathered the ups and downs of the markets since he opened Citadel in 1990 with $4.6 million. This time around, he has stockpiled $6 billion in cash and has lowered his funds’ leverage, which has helped fuel returns in the past. He has also broadened Citadel’s reach in recent years into fee-based businesses typically offered by financial service firms, not hedge funds. The businesses include carrying out trades — Citadel now executes 30 percent of all American option trades and 8 percent of American stock trades. And it performs administrative tasks for other hedge funds.
Despite the diversification, Mr. Griffin will still be judged to a degree for how his largest fund, the Kensington fund, fares during the turmoil.
Traders in the convertible bond market said that Citadel suffered from carnage at other funds. Much of the drop was caused by selling by Lehman’s proprietary trading desk as well as the hedge funds Lydian Asset Management, Whitebox Advisors and Platinum Grove Asset Management, according to traders who asked to remain anonymous because they agreed not to discuss the portfolios they reviewed. Many of those funds owned preferred stock in financial companies like Lehman and Merrill Lynch, but they were forced to sell bonds from a range of industries as they searched for cash.
Lydian and Whitebox did not return calls for comment, and an executive at Platinum Grove declined to comment. A spokesman for Lehman confirmed the selling in the week after the bank filed for bankruptcy.
Many of Citadel’s strategies were also thrown off by the short-selling rules that the government imposed in the middle of last month. Traders say that stocks were moving out of sync from earnings announcements and in patterns that seemed divorced from their research into those companies. The rules are scheduled to last through the middle of October, though they could be extended.
Analysts said that investors might forgive many hedge funds for their September spirals, because of the historic events during the month. But investors may not forgive many more months of pain, they said.
Still, some say Mr. Griffin is in a good position to profit from the pain on Wall Street. Even mighty firms like Goldman Sachs have torn up their playbooks, potentially creating an opening for Mr. Griffin — provided Citadel can bounce back fast.
“Ken Griffin has the attention of the world,” said David DeRosa, chairman of DeRosa Research and Trading, a company in New Canaan, Conn., that advises financial companies, including hedge funds. “Given that we’ve lost the major investment banks, there’s an opening now.”
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Hedge Fund Finds Itself on Defense
By LOUISE STORY
7 October 2008
Kenneth C. Griffin was one of those Wall Street whiz kids. As a teenager, he traded out of his dorm room at Harvard. In his 20s, he opened his own hedge fund. In his 30s, he boasted that his company might one day rival Goldman Sachs.
But it can be tough for a boy wonder to grow up — particularly in the midst of the gravest financial crisis since the Depression. A week before his 40th birthday, Mr. Griffin finds himself in an unaccustomed position: on the defensive.
The Citadel Group of Chicago, the giant hedge fund that Mr. Griffin has run so successfully for nearly 20 years, is leaking money. As of Sept. 30, its two main investment funds were down 20 percent this year, according to Citadel investors. Most of the losses came in the last few weeks, when the markets swooned. Two other smaller Citadel funds are still well in the black.
While many hedge fund high-fliers are falling back to earth this year, few have soared quite as high as Mr. Griffin. With an estimated net worth of $3 billion in 2007, he ranked as the 117th richest American, according to Forbes. (Mr. Griffin paid $60 million for Cezanne’s “Curtain, Jug and Fruit Bowl” in 1999. Four years later, he was married in the garden at Versailles.)
But with the entire hedge fund industry on edge, even Mr. Griffin is considering what once would have been unthinkable: reducing some of the lavish fees that investors pay Citadel to tend their fortunes.
Citadel is developing several new, low-price funds that will eschew the industry’s “2 and 20” structure, whereby funds collect annual management fees of 2 percent and, on top of that, take a 20 percent cut of any profits. Some of the funds will bet only on investments and will not use short sales to hedge, effectively taking the “hedge” out of hedge fund. The funds will provide investors with a menu of à la carte investing options, another departure for Mr. Griffin, as he expands beyond hedge funds into broader asset management.
Gerald A. Beeson, the chief operating officer of Citadel, said no one had seen anything like the turmoil now gripping the financial markets. “Any one of the market events we saw in September could on its own result in a meaningful dislocation,” Mr. Beeson said. “Together they were simply unprecedented.”
Until now, Mr. Griffin has rarely stumbled. Between 1998 and 2007, he handed his investors an average annual return of 20 percent, more than three times that of the Standard & Poor’s 500-stock index. That performance made Mr. Griffin a rich man and fanned his already formidable ambition. Not long ago, he was considering taking Citadel public, a step that might now be difficult, if not impossible, given the state of the markets. Through a spokeswoman, Mr. Griffin, who turns 40 on Oct. 15, declined to comment for this article.
What went wrong? Citadel’s losses this year were largely caused by equity trades and two arbitrage strategies, the first of which involves betting on the outcome of mergers, and the second on convertible bonds.
Now, the clock is ticking for Mr. Griffin. If his funds close down for the year, Citadel will not earn its 20 percent profit fee and will have to finance its growth through past savings. Dismal year-end returns could also put another dent in Mr. Griffin’s aspirations for taking his company public.
Hedge funds are down, on average, 10 percent so far this year, the worst run yet for the private, largely unregulated industry that manages money for some of the largest pension and endowment funds in the world. The losses are threatening the survival of thousands of hedge funds, and pitting traders against each other. As the markets rumbled last month, troubled hedge funds sold investments at rock-bottom prices, and other, stronger funds tried to bet against any stocks or bonds that their weaker peers held.
“The real issue for hedge funds is that the whole environment has changed, and like everyone else, they’re trying to figure out whether they still have some kind of investment edge in this new environment,” said William Goetzmann, a professor of finance at the Yale School of Management. “I think some of them will find that they don’t.”
Already, investors are starting to ask for their money back at large hedge funds like DKR Capital and RAB Capital. Managers like Dinakar Singh, a former Goldman star who runs the hedge fund TPG-Axon, are writing apologetic letters to their investors, asking them to stay put. And analysts are warning that some 10 percent of the 10,000 hedge funds in business may be gone by early next year.
It is a setback for an industry that has created staggering wealth for individuals like Mr. Griffin and raised eyebrows in Washington. The House Committee on Oversight and Government Reform said last week that it would hold a hearing on hedge fund regulation next week, and Mr. Griffin is among the five billionaire hedge fund managers invited to testify.
Citadel is already mapping changes to put it ahead when the chaos ends. The company has been hiring Wall Street workers for its new, low-price funds, a move that angered JPMorgan Chase so much that the bank stopped trading with Citadel for a day. And Citadel has been working on creating a new exchange and clearinghouse for credit-default swaps with the Chicago Mercantile Exchange, an alternative to a plan being promoted by Wall Street firms like Goldman Sachs.
A fiercely competitive trader, Mr. Griffin has weathered the ups and downs of the markets since he opened Citadel in 1990 with $4.6 million. This time around, he has stockpiled $6 billion in cash and has lowered his funds’ leverage, which has helped fuel returns in the past. He has also broadened Citadel’s reach in recent years into fee-based businesses typically offered by financial service firms, not hedge funds. The businesses include carrying out trades — Citadel now executes 30 percent of all American option trades and 8 percent of American stock trades. And it performs administrative tasks for other hedge funds.
Despite the diversification, Mr. Griffin will still be judged to a degree for how his largest fund, the Kensington fund, fares during the turmoil.
Traders in the convertible bond market said that Citadel suffered from carnage at other funds. Much of the drop was caused by selling by Lehman’s proprietary trading desk as well as the hedge funds Lydian Asset Management, Whitebox Advisors and Platinum Grove Asset Management, according to traders who asked to remain anonymous because they agreed not to discuss the portfolios they reviewed. Many of those funds owned preferred stock in financial companies like Lehman and Merrill Lynch, but they were forced to sell bonds from a range of industries as they searched for cash.
Lydian and Whitebox did not return calls for comment, and an executive at Platinum Grove declined to comment. A spokesman for Lehman confirmed the selling in the week after the bank filed for bankruptcy.
Many of Citadel’s strategies were also thrown off by the short-selling rules that the government imposed in the middle of last month. Traders say that stocks were moving out of sync from earnings announcements and in patterns that seemed divorced from their research into those companies. The rules are scheduled to last through the middle of October, though they could be extended.
Analysts said that investors might forgive many hedge funds for their September spirals, because of the historic events during the month. But investors may not forgive many more months of pain, they said.
Still, some say Mr. Griffin is in a good position to profit from the pain on Wall Street. Even mighty firms like Goldman Sachs have torn up their playbooks, potentially creating an opening for Mr. Griffin — provided Citadel can bounce back fast.
“Ken Griffin has the attention of the world,” said David DeRosa, chairman of DeRosa Research and Trading, a company in New Canaan, Conn., that advises financial companies, including hedge funds. “Given that we’ve lost the major investment banks, there’s an opening now.”
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